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Sarb in tight spot with interest rates

May 18 2015 21:04

Carin Smith

George Herman, head of South African portfolios at Citadel Investment Services. (Supplied)

Cape Town - The SA Reserve Bank (Sarb) is caught between a rock and a hard place regarding the upcoming interest rates decision by its Monetary Policy Committee (MPC) on Thursday, according to George Herman, head of South African portfolios at Citadel Investment Services.

Growth is under pressure and continuously being marked lower, whilst inflation is on the rise again. This stagflationary bind makes any one of three policy moves possible, but only one practical, he told Fin24.

The Sarb could be bold and follow the example of India and cut the repo rate on Thursday.

"This would quickly get some stimulus into the SA economy before it starts the long slog of interest rate increases as the Federal Reserve in the United States starts raising or normalising interest rates from the end of 2015 or at the beginning of 2016," explained Herman.

"Reducing rates now, would weaken the rand, but bolster economic growth as it supports the average consumer. The weakening rand would be somewhat inflationary, but would bolster our currently depressed commodity export prices and even help reduce the trade deficit."

If the Sarb, however, followed its own advice of the past and looked through the current cycle, 18 months ahead, they’ll see inflation well above their target range and in anticipation, actually hike interest rates on Thursday, explained Herman.

"This would damage the economy via constrained consumption expenditure, but would throttle off inflation very quickly as the rand should then strengthen materially. This rand strength would very quickly quell inflation expectations and have the desired effect of getting back within the target range," said Herman.

"It would be at the cost of increased labour tensions and higher unemployment though, so it’s very unlikely that they’ll follow this path."

According to Herman many would consider it prudent if the interest rates were left unchanged on Thursday.

"Why move before the Fed and take the risk of being targeted by carry traders or labour unions? Inflation will still be within the target range for a few months and monetary conditions are not too loose currently so they could just wait to see how global growth dynamics affect South Africa’s prospects," said Herman.

"In so doing they provide monetary policy certainty to the markets at a time when regulatory policy uncertainty is at a high. It’s not difficult to see why this is the consensus view for Thursday, but it is a pity that the Sarb can’t be more assertive in boosting our stuttering economy."

In the view of Nedbank rates will remain on hold for an unchanged repo rate at the upcoming MPC meeting.

"Low base effects and other domestic inflationary pressures remain in play since our last Nedbank Interest Rate Barometer and MPC. As such, the probability of a hike later in 2015 remains," the bank said on Monday.

"Disinflationary pressures in the developed world have abated somewhat and inflation expectations have ticked higher. Oil prices have gained and will result in a large base effect late in the year and early in 2016."

"We have long said that the debate around the timing of the Fed hike is less important than the profile of such a hiking cycle. We remain of the opinion that the Fed will hike in September," the bank said.

Peter Attartd Montalto of Nomura said he expects rates to remain unchanged on Thursday, with a broadly unchanged MPC press statement, a strong hawkish tone and lay the groundwork for hikes in the coming meetings.

"Fed views from the statement will be key. We still expect the next hike in July of 25 basis points, but with probability (slowly) falling as Fed take-off skews to later in the year," he said.

"We now see only a 15% probability of a hike at this meeting – that is low. We doubt the MPC will offer any definitive pre-commitment to a hike in July though, after previous 'running out of time' and 'closing window' comments, we expect similar, fairly open-ended, language will have to be maintained."

Brett Birkenstock of Overberg Asset Management expects interest rates to remain unchanged, although the rand has weakened against certain currencies.

"This would be due to a weak economic environment. It is a balancing act between a depreciating rand and rising inflation, and on the other hand a struggling economy and a public with less disposable income," he explained.

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